Retentions are one of the few parts of construction accounting that genuinely work differently from a normal invoice. Get the treatment wrong and you can end up misreporting your debtors, miscalculating VAT, or getting a tax bill on money you haven't actually been paid yet. Here's how retentions should actually be recorded, from the moment they're withheld to the moment they're released.
What are retentions, and why do they need different treatment?
A retention is a slice of a contract's value, commonly 2.5–5%, that the client withholds rather than paying in full at each stage. It's usually released in two parts: half at practical completion, and the rest at the end of the defects liability period, often 12 months later. Until then, the money is legally yours, certified and earned, but not yet in your bank account. That gap between earning it and receiving it is exactly why retentions need to be tracked separately rather than folded into ordinary trade debtors.
Recording retentions in your books
Under normal accruals accounting, you recognise the full value of certified work as revenue when it's earned, including the retained portion, not just the part you've actually been paid. That means the retention still needs to sit on your balance sheet as a debtor, it just isn't cash yet. The mistake we see most often is retentions getting lumped in with general trade debtors, which makes it impossible to see at a glance how much money is tied up, or when it's actually due to come back. A separate nominal code or tracking category for retentions, ideally broken down contract by contract, fixes that in most cloud bookkeeping software without much extra work.
VAT on retentions
This is the part that catches people out. Normally, VAT is due based on your invoice or payment date, whichever comes first. Retentions are a specific exception: under Regulation 89 of the VAT Regulations 1995, the tax point for the retained amount is delayed until you either issue a VAT invoice for it or actually receive it, whichever happens first. In practice, that means you don't need to account for VAT on the retained slice at the time of your original application for payment, only when it's actually invoiced or paid. Getting this wrong in the other direction, paying VAT upfront on money you won't see for a year, is a real and avoidable cash flow cost.
CIS deductions on retentions
There's no special CIS rule for retentions in the sense of a different rate or process, but there is a detail worth knowing: the deduction applied when a retention is finally paid is based on the subcontractor's CIS status on the date of that payment, not their status when the original work was done. If a subcontractor was registered at 20% when the job was completed but has since gained gross payment status, the retention should be paid gross. It can also go the other way. Given retention periods commonly run 12 months or more, it's worth checking status again at release rather than assuming it's unchanged. Our guide to gross payment status covers how that status is gained and lost.
Getting retentions accounting right
Track retentions separately from day one, know the release dates for every live contract, and don't assume VAT or CIS treatment defaults to whatever applied on the original invoice. Retentions on more than one or two live contracts start to genuinely affect cash flow planning, not just bookkeeping tidiness. Our job costing and cash flow forecasting services are built around exactly this: knowing what's tied up, when it's due, and what it means for your tax position before the numbers surprise you.
Rehan Razzaq, FCCA
ACCA Chartered Certified and a Xero Certified Advisor, helping UK construction businesses with accounts, tax and financial planning.
More about Rehan →